I believe this is biology's century. I've covered science and medicine for Forbes from the Human Genome Project through Vioxx to the blossoming DNA technology changing the world today.
Email me, follow me on Twitter, circle me onGoogle Plus, or subscribe to my Facebook page.

Escape From The IRS: Medtronic Looks To Succeed Where Pfizer Failed

Medical device giant Medtronic looks as if it will succeed where the drug behemoth Pfizer failed: it is acquiring a rival in large part to move its tax domicile out of the United States, lowering its tax rate.

Medtronic announced Sunday that it has agreed to purchase Dublin, Ireland’s Covidien for $42.9 billion in cash and stock. Medtronic, now based in Minneapolis, is the second-biggest maker of medical devices after Johnson & Johnson, and is a powerhouse that builds implantable heart devices and equipment used in spinal surgery procedures. It had net income of $3 billion on sales of $17 billion in its last fiscal year. Medtronic will move its corporate headquarters to Dublin, but says it “will continue to have its operational headquarters in Minneapolis, where Medtronic currently employs more than 8,000 people.”

Medtronic EnRhythm* (Photo credit: stev.ie)

That strategy may be the biggest asset Medtronic is getting from Covidien, despite the latter’s $10 billion in annual sales of surgical tools, catheters, and scopes. Until 2007, Covidien was part of Tyco International, the scandal-plagued roll-up (remember Dennis Kozlowski?) that had its tax domicile in Bermuda. Covidien initially kept the Bermuda tax shelter, but two years later moved its headquarters to Ireland. The whole time, much of its operations were based in Marshfield, Massachusetts. Earlier this year, Pfizer, the largest drug giant, tried to purchase London’s AstraZeneca in part to move its tax domicile; the deal ran aground over issues of price and AstraZeneca’s desire to remain independent.

In a press release, Medtronic chief executive Omar Ishrak argued that the deal has other benefits, too, giving the new company increased negotiating power with hospitals and governments and a bigger global footprint. But the U.S. corporate tax rate is 35%, among the world’s highest, while in Ireland it is just 12.5%.

The benefits of changing Medtronic’s address – known as a “tax inversion” – are more complicated than they would first appear. Derrick Sung, an analyst at Sanford C. Bernstein, said in a note to clients that Medtronic’s current 19% tax rate is only two points higher than Covidien’s 17% rate. (Medtronic’s tax rate might go up as it resolves a dispute with the Internal Revenue Service, but would remain low, Sung says.)

But Medtronic currently has $14 billion in cash on its books, and half of that money is overseas. Spending it in the U.S. would mean paying U.S.-level taxes on it. But domiciling in Ireland will allow Medtronic to spend the money with a far lower tax rate. Sung told his clients that the deal could be 7% to 12% dilutive to Medtronic, but that tax benefits may well make up much of that difference.

There’s an obvious reason for Medtronic to push for financial innovations: sales growth from its technological ones has been slow. Last year Medtronic grew its revenues just 2.5%. And innovation has been hard. In 2010, Medtronic spent $800 million, plus milestones to be paid in the future, on a startup called Ardian that had a new device for controlling high blood pressure. “I couldn’t be more excited,” its then CEO, William Hawkins, told me. In April, the device failed to show any benefit in a large clinical trial.

Pfizer’s attempt to flee its U.S. tax base was a warning shot to American legislators; Medtronic’s departure appears to be the real deal. Congress should take the warning, and move quickly both to lower U.S. tax rates (so that companies will feel less need to flee) and to create new barriers to companies executing tax inversions.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.